Which model of financial adviser fees is right for me?

The question of financial adviser fees and the method charged has long been deliberated over, both internally in the industry, and from a client perspective. Like many professional services, the immediate ‘return on investment’ from financial advice can be challenging to quantify and validate. But having a good understanding of how you are charged can undoubtedly help. In this article, I will run through the three main methods for charging for financial advice, along with some thoughts on the benefits and potential drawbacks of each technique.

Commissions

Commissions, as found in many other industries, are payments made to a referrer (or, adviser) for placing a client into a product or service. The issue with commissions in financial advice was the opaqueness, or complete absence of disclosure of them. Clients would think they were getting financial advice that was in their best interests, but were in-fact just being sold to. To understand the significance of this, compare it to when you’re purchasing a car. In this case you know the salesman is going to be getting a commission, and can factor this into your decision, and objectively assess the car for your purposes yourself. If you thought the car salesman was working for your best interests, not his, and didn’t know anything about cars, you might be more likely to blindly accept his advice. As was the case in financial advice. 

Cheaply made or high-cost products often then had the ability to pay the highest commissions, further fueling the impact this part of the industry had on retail clients. Increasingly sales-driven practices by some product providers were one of the catalysts for the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (The Hayne Commission). Indeed, some of the larger financial product and advice providers had introduced high-pressure sales systems into their practices. This sales-oriented culture was not unique to Australia.

Thankfully, conflicted remuneration (commissions), where the outcome of the advice typically leads to additional revenue paid to the financial advisers from the product provider, has been banned, and grandfathered commissions are being phased out by the first of January 2021. But the lesson stands to always check the relevant and associated relationships, which adviser are now required by law to disclose.

Assets under management (AUM)

(Also known as funds under management (FUM))

The assets under management model charges clients a percentage-based fee to the financial adviser based on their portfolio value.

Benefits can include that clients can pay their adviser fees from their managed assets. As the portfolio decreases, the fee for service decreases.

The client’s adviser may achieve a higher return as they are essentially incentivised to perform when their income is dependent on assets under management increasing/performance.

A potential conflict of interest may exist when recommending investments based on assets under management. If the percentage-based fee differs across asset classes, the financial adviser could earn higher revenue by recommending the client invest in the higher cost assets.

The adviser may place clients in riskier investments that are not suited to their risk tolerance to receive more revenue.

Systemic risk (like the COVID-19 pandemic) can reduce the adviser’s fees as overall assets under managed could fall. If the client draws-down lump sums of their balance, the adviser’s assets under managed will fall, leading to a fall in revenue.

If the adviser is not directly responsible for some part of the investment process (i.e. Stock selection or asset allocation) but instead just vetting the quality and reliability of the investments selected, then the assets under management model is more tenuous to accept. Your investment balance size does not have a significant bearing on the overall cost of the work required, and perhaps a fixed fee for service may be more appropriate.

Fee for Service

The fee for service model charges clients:

  • based on what the standard fees for a client with a similar size portfolio are; or 
  • the client can be charged based on complexity – i.e. a set charge for each service is added to the ‘standard’ fee.

Benefits include that the client is charged a standard fee and knows what they are paying up-front, and can ensure fair payment based on the complexity of services required. Besides, revenue is more certain from an adviser’s perspective, which can help with business planning and client segmentation. This fee method also separates the adviser’s performance from market performance.

Drawbacks can include that this may allow charging based on a ‘standard price’ for funds managed, similar to the assets under management model, so it’s really just a horse by a different name. The adviser then has the discretion to charge the client what they ‘think’ they can pay. This may mean that there is no uniformity in the pricing and brings the risk of undercharging if the client’s needs become more complex than initially thought.

Hourly rates

Many other professionals and tradespeople, including accountants, specialist doctors, engineers, mechanics, and plumbers, charge an hourly rate for services rendered.

Benefits include a set maximum rate per hour, charged based on complexity/as required. The financial adviser is charging a fee for their expertise but reserves the right to increase above the quoted amount as needed.

Drawbacks can be that the adviser could ‘make-up’ hours but complete the work for a client in less time, often called ‘padding’ work. Clients may not precisely understand the basis for the charges they are paying.

Suppose the adviser forgets to record the hours whilst working with the client and, days later, tries to record the information. In that case, there is the potential to under or overcharge for services.

Conclusion

It is unlikely that each of these models could be considered more ‘ethical’ than one another. In a perfect world, clients should choose their preferred method of compensation of their advisers, and that a combination of how financial adviser’s fees are paid may be more appropriate and ‘fair’ to the client. Keep in mind that perhaps a combination of the above may be the best fit, where an initial, and often more involved, piece of work is priced in one way, usually fee for service, then moved to a more reflective model, such as assets under management for ongoing service.

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Tim Fuller is Head of Advice at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Tim Fuller is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd – AFSL 515796.

Tim Fuller

Comments

  1. reusachtigeMEMBER

    Thankfully property investment does not need a financial adviser. The best advice comes from those with skin in the game. And media experts like Doctor Wilson. And property always gives the best returns as it always booms!

    • 4,200 we come

      There’s a reason we say “safe as houses”. Steven Keen is 68 and still renting lol.

    • Property has a 4% transaction friction.

      Property managers have an ICR of what ? 8?

      LULZ

    • Comes down to what advice is being sought and given. Clearly most advice is pretty general in nature but the industry has captured itself so well that all advice is seen as top end advice and is charged accordingly.

  2. The issue is no advisor has ever outperformed the index over the longer term?
    Also the idea that these guys can add value via asset allocation is also complete bllsht.

    Always manage your own affairs, as no one cares more than you.
    Index funds across the sectors you like best.

    • “The issue is no advisor has ever outperformed the index over the longer term?”

      Neither has any unadvised investor, if skill is the criteria being measured.

      “Also the idea that these guys can add value via asset allocation is also complete bllsht”

      There is no better way of removing systemic investment risk than diversification. Asset allocation is a tool to dampen the psychological response to market decline, as tendencies are to retract from a strategy and people putting money into 100% cash or the like, typically at the bottom of the market.

      Otherwise, everyone would have a 100% growth asset allocation.

      “Always manage your own affairs, as no one cares more than you.”

      The best affairs you can manage is your own profitable vocation, which will generate a greater return than any passive asset. A very good method to optimise the return on your exertion, it to be allowed to focus on it entirely, because one has a trusted person managing other affairs, such as tax, superannuation, insurance, etc, the strategic parts of financial advice.